The real estate and equity markets are walking a tightrope this year. Both will strive to maintain their balance on an economic foundation that is shifting.
On one end of the tightrope is a hot (but cooling?) US and global economy. Strong jobs growth and consumer confidence are driving the economy forward. However, fading stimulative measures (mainly tax cuts) are losing their effectiveness and will all but disappear in the short-run. With these changes in store, how long will the tail winds last and will consumers’ confidence last?
On the other end are a host of headwinds, cross-winds, and whirlwinds that could blow us off the tightrope at any time. The Federal Reserve is tightening interest rates to get ahead of inflation. If rates rise too high, too quickly, the Fed could hurt the economy on many levels. In addition, other factors including basic politics, trade disputes, debt loads, and other countries’ economic problems may knock us off balance. Will any of these issues push us into a recession? Who knows, but it seems there are more opportunities to slip up than there are to maintain course.
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Trying to predict where the economy is going and timing the market is extremely difficult. Arguably, it’s not possible for the lay person or the experienced trader. What we should ask is how to invest in today’s markets confidently. The answer is to approach each investment with additional caution and prudent analysis. But isn’t that how you should always invest? Yes, of course. Yet over the last 10 years, many seem to have forgotten that rents don’t always rise, stocks do drop, and layoffs happen. Penciling in some of the downside scenarios is important to making sure your investments survive in down markets.
Many of the beginning of the year “prediction” reports are recommending staying the course. Commercial real estate (CRE) remains a strong place to park capital while multifamily and other similarly “lower risk” CRE is still attracting the most capital. But, capitalization rates are extremely low and purchase price per unit are very high, two indicators that investors are paying a lot for the yield achieved. I believe price expectations have run ahead of market realities and that a pricing disparity exists. So how do we navigate to the other side? How long will it take for the market to price in more realistic rent growth expectations, economic factors, and higher interest rates?
It’s hard to tell, however, it’s imperative at this point in the market to pencil your opportunities with plenty of margin lest the fundamentals shift under your feet. Don’t be caught off guard by optimistic underwriting. More than ever it’s time to keep your underwriting real, and make sure you can survive the pessimistic scenarios. After all, it’s looking more and more likely that a slip on the tightrope will lead to consumers second guessing their confidence in this economy. Are we going to fall off? Probably not, but expect a pause long enough for the market to catch its breath. It’s time to reflect on the last 10 years’ run up and think about capital preservation, not only growth opportunities.
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